May we live in interesting times

By Sam Reiss

Reportedly an English translation of a Chinese proverb, “May you live in interesting times” has just as often been labelled a curse. Whatever the case, it seems we’re on the brink of some interesting times indeed.

The Bank of Canada last week released its bi-annual Financial Review System, and while they maintain that key risks “emanate primarily from the external environment,” there are also some homemade problems afoot. Primary among them is record high household debt, driven by record-low interest rates. The other potentially significant problem? “Stretched valuations in some segments of the housing market” — in other words, inflated prices in key markets like, say, Toronto.

The ratio of household debt is up 1.5% from the Bank’s June release, to 163% of disposable income. The pace has slowed, and the Bank says it expects credit growth to further moderate “since housing activity is projected to move back in line with demographic demand.”

Household debt renders Canadians particularly vulnerable to the twin threats of a big drop in housing prices and a sharp decline in employment, which the release calls “inter-related shocks.” In other words, a big messy ball of potentially circular problems — more debt means less housing activity, which leads to fewer jobs, which leads to lack of confidence, which leads to less household spending, which leads to less housing activity … Throw in the resultant loan losses for financial institutions, and we could be in for some big ripples.

Not surprisingly, the condo market was singled out as a potential catalyst. “A specific concern is that the total number of housing units under construction has been increasing and is now well above its historical average relative to the population,” the release says, a development almost entirely attributable to multiple-unit dwellings in big cities: unsold high-rise units in the pre-construction phase have doubled since June 2011, and high-rise unit prices have flattened while sales have declined.

The release says domestic growth is likely to be “modest,” thanks to trade links with more troubled countries, the Eurozone debt crisis, and scheduled tax hikes in the U.S. The effects could lead to “rising costs for loans and tighter lending conditions for Canadian households and businesses.”

The government and the central bank’s Carney continue to call for consumer caution, urging the overly indulgent to limit their debt and prepare for the inevitable higher interest rates; the current rate is holding at 1%, just a tad over its record low set in September 2010.

But regardless of what the Bank of Canada does, or what Carney does, it’s what we do, each of us, that counts. As consumers, it’s time to stop borrowing more than we can afford, and as business people, it’s time to stop taking crazy risks we wouldn’t take if the rates weren’t so low. In spite of the extra debt, our default and insolvency rates remain low, so let’s put our grown-up pants on and do what it takes to keep them that way, instead of letting this be the calm before the storm.

And while we’re trying to do the right thing, let’s not complain when the lenders — as they should — start tightening up their borrowing requirements. Accountability is a great financial advisor.